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Tax-Selling Season Could Make You 50% On This Struggling Stock

 November 16, 2012 01:54 PM

Despite the recent market weakness, many traders and fund managers have enjoyed big gains this year. Even after the election week sell-off, the S&P 500 and Nasdaq 100 indexes are up more than 10% since the start of the year.

For tax purposes, some individual traders and fund managers may want to offset gains by selling any losing positions they hold. Even managers of nontaxable accounts often get rid of losing positions ahead of the end of the year so they will not have to report all of their individual mistakes to investors in annual statements.

One way to take advantage of this behavior is to short stocks that are likely to come under selling as the year draws to a close. One stock that may see selling pressure increase is fashion accessory maker Fossil (Nasdaq: FOSL), which is best known for its watches.

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Fossil has been a very successful company with revenue totaling more than $2.7 billion in the past 12 months, and earnings per share (EPS) growing at more than 31% a year in the past five years. But EPS growth is expected to fall to about 18% in the next five years, and traders have been selling the stock since May when the company announced that sales were slowing in Europe and Asia.

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The chart above highlights two high-volume buying days that occurred in the beginning of 2012 when buyers were adding Fossil to their portfolios at prices of $100 to $140 a share. Some sold their positions in May, but there are probably still some buyers with a cost basiswell above the recent price levels near $80. Another large volume day took place in August, and those buyers are also now facing losses.

On-balance volume (OBV), an indicator that moves higher when trading is bullish and falls when the bears are selling a stock, is shown at the bottom of the chart. This indicator shows that buying pressure was very strong early in the year, but there has not been a lot of selling pressure since May.

The steadiness of OBV shows that many traders seem to be holding their positions and expecting a rebound. The next chart shows that they may be disappointed.

From the monthly and weekly perspectives, Fossil is bearish. The monthly chart shows a recent stochastics sell signal, and this signal has been accurate 57% of the time on trades lasting two months. Because Fossil has been in a long-term uptrend, only 36% of all two-month periods in the stock's trading history have been down, so the number of correct trading signals given by the stochastics is significant. The weekly chart shows a bearish stochastic divergence in addition to a sell signal.

Fossil is a volatile stock, and options prices show that traders are expecting a big move in the stock before the end of the year. The stock is trading at about $80. January $80 puts are trading at about $6. Option prices indicate that traders expect a price move of at least 7.5% within the next 60 days, nearly three times the volatility expected of the overall stock market. Options on SPDR S&P 500 (NYSE: SPY) show that a move of about 2.8% is expected in the ETF over the same time frame, which is a rough guide as to how much market volatility is expected.

Based on the daily chart, a price target of about $70, which is the bottom of that August gap, is a reasonable price target. At $70, an $80 put would be worth at least $10. Even though the January $80 puts are expensive, traders could realize a potential gain of more than 50% if the target is reached.

Action to Take --> Buy Fossil Jan 80 Puts at $6.67 or less. Set stop-loss $1.90 below the entry price. Set price target at $10 for a potential 50% gain in two months.

--Michael Carr



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